Chapter 4, Problem 1QFT

To determine

Concept Introduction:

During price rise of a good, lenders are ready to provide loans to the borrowers who pledge their good as the collateral. If the borrowers fail to repay their debt, the recovery is made by selling those goods. As the price continues to increase there is a capital gain for the lenders. As a result, they see very little downside risk of giving a loan. When the price suddenly falls, they suffer a huge loss.

Answer to Problem 1QFT

Lenders were benefitted a lot from the restriction on the number of New York City taxi. Due to restriction on numbers of the taxi, they provided a huge loan to finance the purchase of taxi Medallions and hence, earned lots of profit.

Explanation of Solution

• Many financial companies provided loans to the people for buying taxis. If the borrowers failed to repay the loan the companies took the possession of the taxis. As the price of a taxi was rising continuously, it provided lenders capital gain in case of default.

• If there wasa restriction on the number of taxis, the demand for taxi Medallionswas increased. As a result, loans offered by financial companies increased. The interest on manyloans provided them huge profits.